On the whole, the Reserve Bank of India Monetary Policy Review
and other macro-economic data presents a picture of an improving economy.
Inflation remained benign in March. The Consumer Price Index was up 4.3 per cent year-on-year.
This suggests the Monetary Policy Committee's (MPC) inflation target is realistic. The MPC targets an ideal rate of 4 per cent year-on-year within a band of plus/minus 2 per cent. The MPC projects inflation will remain inside 4.7-5.1 per cent in the first half (April-September 2018) and fall to 4.4 per cent in second half (October 2018-March 2019). GDP growth will accelerate, from 6.6 per cent in 2017-18 to 7.4 per cent in 2018-19. Assuming a normal monsoon (the current prediction) food prices will stay under control. Uneven rain could cause a spike in food prices.
Another obvious risk is crude oil prices, which are now above $72 per barrel. Opec is committed to a production squeeze, targeting at least $80 per barrel levels.
If domestic demand strengthens, that will also push up inflation. The increase in house rent allowance (HRA) for central government employees will drive inflation and there may be a staggered impact of HRA hikes, by state governments. One big worry is a possible overshoot of the central fiscal deficit from the 3.5 per cent of GDP in the Budget estimates. There may also be overshoots of state fiscal deficits. Household expectations continue to be biased towards higher inflation according to the RBI's surveys. Firms polled in the RBI's Industrial Outlook Survey also expect price rises.
Another worry is a rising trade deficit of $157 billion and a possible current account deficit that could go over 2.6 per cent of GDP for the 2018-19 fiscal. However, exports have grown at 9.8 year-on-year for 2017-18, which is a good sign.
The latest Index of Industrial Production (IIP) data shows growth at 7.1 per cent year-on-year in February - that's the fourth month in succession the IIP has registered over 7 per cent. It's running at 5.3 per cent for the 2017-18 fiscal. Manufacturing rose to 8.7 per cent and Infrastructure and Construction rose by 12.6 per cent. If the IIP is accurate, the construction and infrastructure sector should see significant improvement in Q4'FY18. This would be a turnaround story since construction has done badly for many quarters.
There are some things that the MPC statement did not really discuss. One is the impact of the banking crisis on commercial interest rates. Inflation is down. But banks are in no position to cut rates until the enormous quantum of NPAs (bad loans) is wiped off.
Secondly, despite assurances from the government that it will borrow less, the bond market has pushed yields up for many months. That's due to fears that government borrowing through 2018-19 (remember it's election year) will crowd out private investments.
Given CPI (consumer price index) inflation at below 5 per cent and wholesale price inflation (WPI) at below 2.5 per cent, the real interest rates for commercial borrowers are high. Ditto for home-mortgages and auto-loans. The cost of financing has therefore, not eased alongside inflation. The high cost of capital could impact margins and impede new investments.
Under the circumstances, the automobile sector is of particular interest. Sales have been good in both urban and rural markets. But, the cost of inputs - metals, plastic, rubber, wiring, etc has risen. The sector is capital-intensive across the entire chain. Auto-makers have high needs for working capital and most vehicles are bought on hire-purchase.
The automobile sector also has a very long and complex value chain, starting with mining at one end and ending with high-end marketing and advertising services. It is also a barometer of consumption demand. The Q4 results in the auto industry could offer signals about trends across the entire economy.